The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Monday, November 5, 2012

In his Bloomberg column, William Cohan argues that the winner of the presidential election must repair the "rift" between Washington and Wall Street as America functions best when they have a "symbiotic, rather than adversarial, relationship".

This argument is flawed as history has shown that America functions best when Washington requires

Wall Street to provide transparency in all of the opaque corners of the financial system and

Investors use this transparency knowing they are responsible for all gains and losses on their exposures under the principal of caveat emptor.

By definition, Washington's requirement of Wall Street creates an adversarial relationship. The reason that it is an adversarial relationship is that Wall Street likes opacity as opacity allows Wall Street to make a lot of money off of the inability of investors to properly value the risk of a security.

Yves Smith confirmed this on NakedCapitalism with her observation that nobody on Wall Street was ever highly compensated for creating transparent, low margin products.

On Wall Street, opacity is a winner.

For America, transparency is a winner.

Therefore, it is up to Washington to act in America's best interest and make sure that there is transparency is every corner of the financial system.

History has shown that America functions worse when Washington tries to 'befriend or make a client of' Wall Street.

First the Great Depression and now the Great Recession show how America and its capital markets function at their worse when Washington pursues a 'symbiotic' relationship and does not ensure that there is transparency in every corner of the financial system.

Each part of the financial system that broke down in the Great Recession is characterized by its opacity: including, but not limited to, structured finance securities and banks.

Regardless of whether Mitt Romney or Barack Obama wins the presidential election Tuesday night, one of the first orders of business will be to repair the deep rift between Washington and Wall Street.

Plenty of Americans may feel that the antagonism between the two is useful -- and lord knows there have been times in recent history when the relationship between the power centers in Washington and New York City has been unbearably cozy. Yet the truth is that America functions best when Wall Street and Washington have a symbiotic -- rather than adversarial -- relationship....

The financial system is dependent on antagonism between the two as transparency is the casualty of a friendly relationship.

Please recall that FDR welcomed the bankers' enmity when he set up the FDR Framework as the foundation for our financial system. He knew full well that requiring transparency would dramatically reduce the profitability of Wall Street. He saw this as a good thing because the profits came at the expense of America's real economy.

So, whichever man wins, he should get to work immediately on improving the vibes between Washington and Wall Street. Here’s how to do it, in three simple steps:

First, don’t pretend the problem doesn’t exist. Yes, it is true that during the past four years Wall Street has benefited enormously under President Barack Obama -- from the trillions of dollars used to bail out failed firms to the doubling of the Standard & Poor’s 500 Index (SPX) since its 2009 nadir to the failure to put in place meaningful regulatory reform to the Federal Reserve’s decision to keep interest rates low. ...

The Dodd-Frank reform act remains the law of the land, banks remain under the (often heavy-lidded) eye of the watchdog agencies, and uber-capitalist Romney, one hopes, understands that markets won’t function unless the people have faith in them being fair.

What a litany of doing Wall Street's bidding and not re-establishing the right relationship between Washington and Wall Street.

Rather than focus on bringing transparency to every corner of the financial system, the focus has been on promoting opacity with complex rules/regulations and regulatory oversight.

To put things on a new footing, I suggest a weekend retreat ... to figure out how to salve feelings bruised by the endless battles over how the new regulation of Wall Street will work.

History shows that FDR did not care about Wall Street's bruised feelings. He understood that Wall Street is filled with big boys who understand, even if they don't like it, that forcing them to provide transparency is nothing personal. It is simply stripping them of an information advantage that undermines the financial markets by making them unfair.

What would they discuss at such a retreat? The other two items on my agenda.

One of which is that, while federal agencies need to quickly wrap up writing the rules called for under Dodd-Frank, the government should actually let Wall Street banks take more risk with their capital than Dodd-Frank law implies they should.

Your humble blogger has argued for the repeal of Dodd-Frank with the exception of the Consumer Financial Protection Bureau and the Volcker Rule. In its place, Washington needs to bring back transparency to all the opaque corners of the financial system.

For banks, this will require that they provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details. With this information, banks will be subject to market discipline in addition to regulatory discipline as a restraint on their risk taking.

For structured finance securities ranging from covered bonds to securitizations this will require they provide observable event based reporting on all activities like payments or delinquencies involving the underlying collateral before the beginning of the next business day.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.